Item 1. Financial Statements
ITEM 1. FINANCIAL STATEMENTS
SMITHFIELD FOODS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in millions, except per share data)
Three Months Ended
July 28,
2013
July 29,
2012
(unaudited)
Sales
$
3,393.3
$
3,091.3
Cost of sales
3,089.1
2,759.1
Gross profit
304.2
332.2
Selling, general and administrative expenses
205.2
201.1
(Income) loss from equity method investments
1.7
(0.7
)
Operating profit
97.3
131.8
Interest expense
41.8
42.5
Income before income taxes
55.5
89.3
Income tax expense
16.0
27.6
Net income
$
39.5
$
61.7
Net income per share:
Basic
$
.28
$
.40
Diluted
$
.27
$
.40
Weighted average shares outstanding:
Basic
139.0
154.3
Effect of dilutive shares
4.9
1.0
Diluted
143.9
155.3
See Notes to Consolidated Condensed Financial Statements
3
SMITHFIELD FOODS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
Three Months Ended
July 28,
2013
July 29,
2012
(unaudited)
Net income
$
39.5
$
61.7
Other comprehensive income (loss), net of tax:
Foreign currency translation
4.3
(84.1
)
Pension accounting
9.1
8.2
Hedge accounting
(27.0
)
59.2
Total other comprehensive loss
(13.6
)
(16.7
)
Comprehensive income
$
25.9
$
45.0
See Notes to Consolidated Condensed Financial Statements
4
SMITHFIELD FOODS, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(in millions, except share data)
July 28,
2013
April 28,
2013
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents
$
192.8
$
310.6
Accounts receivable, net
767.9
663.2
Inventories
2,353.2
2,348.3
Prepaid expenses and other current assets
154.9
229.7
Total current assets
3,468.8
3,551.8
Property, plant and equipment, net
2,336.2
2,298.4
Goodwill
826.2
782.4
Investments
533.6
532.4
Intangible assets, net
389.6
390.4
Other assets
169.8
161.0
Total assets
$
7,724.2
$
7,716.4
LIABILITIES AND EQUITY
Current liabilities:
Current portion of long-term debt and capital lease obligations
$
210.9
$
676.1
Accounts payable
468.9
429.1
Accrued expenses and other current liabilities
554.5
641.0
Total current liabilities
1,234.3
1,746.2
Long-term debt and capital lease obligations
2,290.7
1,829.2
Other liabilities
1,023.7
1,030.6
Redeemable noncontrolling interests
48.6
12.7
Commitments and contingencies
Equity:
Shareholders' equity:
Preferred stock, $1.00 par value, 1,000,000 authorized shares
—
—
Common stock, $.50 par value, 500,000,000 authorized shares; 139,189,923 and 138,919,056 issued and outstanding
69.6
69.5
Additional paid-in capital
1,393.6
1,389.9
Stock held in trust
(69.2
)
(68.8
)
Retained earnings
2,362.1
2,322.6
Accumulated other comprehensive loss
(629.8
)
(616.2
)
Total shareholders’ equity
3,126.3
3,097.0
Noncontrolling interests
0.6
0.7
Total equity
3,126.9
3,097.7
Total liabilities and equity
$
7,724.2
$
7,716.4
See Notes to Consolidated Condensed Financial Statements
5
SMITHFIELD FOODS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in millions)
Three Months Ended
July 28,
2013
July 29,
2012
(unaudited)
Cash flows from operating activities:
Net income
$
39.5
$
61.7
Adjustments to reconcile net cash flows from operating activities:
Depreciation and amortization
62.9
58.8
(Income) loss from equity method investments
1.7
(0.7
)
Pension expense
27.0
24.0
Pension contributions
(9.1
)
(8.6
)
Changes in operating assets and liabilities and other, net
(108.9
)
(67.9
)
Net cash flows from operating activities
13.1
67.3
Cash flows from investing activities:
Capital expenditures
(76.4
)
(61.2
)
Acquisitions, net of cash acquired
(32.8
)
—
Net expenditures from breeding stock transactions
(5.6
)
(6.5
)
Proceeds from the sale of property, plant and equipment
1.5
6.5
Advance note
(10.0
)
—
Net cash flows from investing activities
(123.3
)
(61.2
)
Cash flows from financing activities:
Proceeds from the issuance of long-term debt
—
24.2
Principal payments on long-term debt and capital lease obligations
(457.2
)
(4.2
)
Net proceeds from revolving credit facilities and notes payable
449.0
6.5
Repurchase of common stock
—
(145.3
)
Other
—
0.2
Net cash flows from financing activities
(8.2
)
(118.6
)
Effect of foreign exchange rate changes on cash
0.6
(3.7
)
Net change in cash and cash equivalents
(117.8
)
(116.2
)
Cash and cash equivalents at beginning of period
310.6
324.3
Cash and cash equivalents at end of period
$
192.8
$
208.1
See Notes to Consolidated Condensed Financial Statements
6
SMITHFIELD FOODS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1 :
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. You should read these statements in conjunction with the audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended April 28, 2013 . The information reflects all normal recurring adjustments which we believe are necessary to present fairly the financial position and results of operations for all periods included.
Smithfield Foods, Inc., together with its subsidiaries (the “Company,” “we,” “us” or “our”), is the largest hog producer and pork processor in the world. We produce and market a wide variety of fresh meat and packaged meats products both domestically and internationally. We conduct our operations through four reportable segments: Pork, Hog Production, International and Corporate, each of which is comprised of a number of subsidiaries, joint ventures and other investments.
The three months ended July 28, 2013 correspond to the first quarter of fiscal 2014 and the three months ended July 29, 2012 correspond to the first quarter of fiscal 2013 .
Net Income per Share
We present dual computations of net income per share. The basic computation is based on weighted average common shares outstanding during the period. The diluted computation reflects the potentially dilutive effect of common stock equivalents, such as stock options and convertible notes, during the period. We excluded stock options for approximately 0.5 million and 2.1 million shares for the three months ended July 28, 2013 and July 29, 2012 , respectively, from the diluted computation because their effect would have been anti-dilutive.
Recently Issued Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (ASU 2013-02). This update does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the update requires additional disclosures about amounts reclassified out of accumulated comprehensive income by component. We adopted this new guidance effective for the first quarter of fiscal 2014. The required disclosures are contained in Note 9 -Shareholders' Equity.
NOTE 2 :
ACQUISITIONS
Kansas City Sausage Company, LLC
In May 2013 (fiscal 2014), we acquired a 50% interest in Kansas City Sausage Company, LLC (KCS) for $36.0 million in cash. Upon closing, in addition to the cash purchase price, we advanced $10.0 million to the seller in exchange for a promissory note, which is secured by the remaining membership interests in KCS held by the seller (the Advance Note). The Advance Note was recorded in other assets in the consolidated condensed balance sheet. Additionally, we entered into a revolving loan agreement with KCS, under which we agreed to make loans from time to time up to an aggregate principal amount of $20.0 million . The aggregate amount of any obligations incurred under the revolving loan agreement is secured by a first priority security interest in all of the assets of KCS.
KCS is a leading U.S. sausage producer and sow processor with annual revenues of approximately $200 million . The merging of KCS's low-cost, efficient operations and high-quality products with our strong brands and sales and marketing team should contribute growth in our packaged meats business. KCS operates in Des Moines, Iowa and Kansas City, Missouri. In Des Moines, KCS produces premium raw materials for sausage, as well as value-added products, including boneless hams and hides. The Kansas City plant is a modern sausage processing facility and is designed for optimum efficiency to provide retail and foodservice customers with high quality products. With our strong ongoing focus on building our packaged meats business, and with 15% of the U.S. sow population, this joint venture is a logical fit for the Company. It is expected to provide a growth
7
platform in two key packaged meats categories — breakfast sausage and dinner sausage — and to allow us to expand our product offerings to our customers. These categories represent over $4.0 billion in retail and foodservice sales annually.
KCS is managed by its Board of Directors, which makes decisions that most significantly impact the economic performance of KCS. We have the right to nominate and elect the majority of the members of the Board of Directors of KCS, and based on the associated voting rights, we have determined that we have a controlling financial interest in KCS. As a result, the acquisition of our interest in KCS was accounted for in the Pork segment using the acquisition method of accounting, which requires, among other things, that assets acquired, liabilities assumed and noncontrolling interests in the acquiree be recognized at their fair values as of the acquisition date. Our initial accounting for KCS is not yet complete as we are in the process of determining final values for the assets acquired, liabilities assumed and noncontrolling interests. Therefore, the amounts contained in the following table, which summarizes our initial estimate of the fair values of assets acquired, liabilities assumed and noncontrolling interests recognized as of the date of acquisition for KCS, are subject to change.
(in millions)
Cash and cash equivalents
$
3.2
Accounts receivable
11.3
Inventories
6.5
Prepaid expenses and other current assets
0.7
Property, plant and equipment
17.5
Goodwill
43.5
Assets acquired
82.7
Accounts payable
9.5
Accrued expenses and other current liabilities
1.1
Other liabilities
0.1
Liabilities assumed
10.7
Noncontrolling interest
36.0
Purchase price
$
36.0
Our initial estimate of the fair value of the noncontrolling interest was measured based on market multiples for similar companies in our industry and consideration of the terms of the acquisition, which provide the noncontrolling interest holder the right to exercise a put option at any time after the fifth anniversary of the acquisition, which would obligate us to redeem their interest. The noncontrolling interest is classified outside of equity as redeemable noncontrolling interests in the consolidated condensed balance sheet. The redemption amount is the greater of $45.0 million or the result of a computed amount based on a fixed multiple of earnings. We have elected to accrete changes in the redemption amount of the noncontrolling interest over the five year period until it becomes redeemable. If the noncontrolling interest had been redeemable as of July 28, 2013 , the redemption amount would have been $45.0 million .
8
NOTE 3 :
INVENTORIES
Inventories consist of the following:
July 28,
2013
April 28,
2013
(in millions)
Livestock
$
1,142.0
$
1,113.5
Fresh and packaged meats
962.5
960.8
Grains
133.1
162.0
Manufacturing supplies
64.3
57.7
Other
51.3
54.3
Total inventories
$
2,353.2
$
2,348.3
NOTE 4 :
DERIVATIVE FINANCIAL INSTRUMENTS
Our meat processing and hog production operations use various raw materials, primarily live hogs, corn and soybean meal, which are actively traded on commodity exchanges. We hedge these commodities when we determine conditions are appropriate to mitigate price risk. While this hedging may limit our ability to participate in gains from favorable commodity fluctuations, it also tends to reduce the risk of loss from adverse changes in raw material prices. We attempt to closely match the commodity contract terms with the hedged item. We also periodically enter into interest rate swaps to hedge exposure to changes in interest rates on certain financial instruments and foreign exchange forward contracts to hedge certain exposures to fluctuating foreign currency rates.
We record all derivatives in the balance sheet as either assets or liabilities at fair value. Accounting for changes in the fair value of a derivative depends on whether it qualifies and has been designated as part of a hedging relationship. For derivatives that qualify and have been designated as hedges for accounting purposes, changes in fair value have no net impact on earnings, to the extent the derivative is considered perfectly effective in achieving offsetting changes in fair value or cash flows attributable to the risk being hedged, until the hedged item is recognized in earnings (commonly referred to as the “hedge accounting” method). For derivatives that do not qualify or are not designated as hedging instruments for accounting purposes, changes in fair value are recorded in current period earnings (commonly referred to as the “mark-to-market” method). We may elect either method of accounting for our derivative portfolio, assuming all the necessary requirements are met. We have in the past availed ourselves of either acceptable method and expect to do so in the future. We believe all of our derivative instruments represent economic hedges against changes in prices and rates, regardless of their designation for accounting purposes.
We do not offset the fair value of derivative instruments with cash collateral held with or received from the same counterparty under a master netting arrangement. As of July 28, 2013 , prepaid expenses and other current assets included $80.7 million representing cash on deposit with brokers to cover losses on our open derivative instruments. As of July 28, 2013 , we had no cash on hand to cover gains on our open derivative instruments. Changes in commodity prices could have a significant impact on cash deposit requirements under our broker and counterparty agreements. Additionally, certain of our derivative contracts contain credit risk-related contingent features, which would require us to post additional cash collateral to cover net losses on open derivative instruments if our credit rating was downgraded. As of July 28, 2013 , the net liability position of our open derivative instruments that are subject to credit risk related contingent features was not material.
We are exposed to losses in the event of nonperformance or nonpayment by counterparties under financial instruments. Although our counterparties primarily consist of financial institutions that are investment grade, there is still a possibility that one or more of these companies could default. However, a majority of our financial instruments are exchange traded futures contracts held with brokers and counterparties with whom we maintain margin accounts that are settled on a daily basis, thereby limiting our credit exposure to non-exchange traded derivatives. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. As of July 28, 2013 , we had credit exposure of $8.1 million on non-exchange traded derivative contracts, excluding the effects of netting arrangements. As a result of netting arrangements, we had no credit exposure as of July 28, 2013 . No significant concentrations of credit risk existed as of July 28, 2013 .
The size and mix of our derivative portfolio varies from time to time based upon our analysis of current and future market conditions. All derivative contracts are recorded in prepaid expenses and other current assets or accrued expenses and other current liabilities within the consolidated condensed balance sheets, as appropriate.
9
The following table presents the fair values of our open derivative financial instruments in the consolidated condensed balance sheets on a gross basis.
Assets
Liabilities
July 28,
2013
April 28,
2013
July 28,
2013
April 28,
2013
(in millions)
(in millions)
Derivatives using the "hedge accounting" method:
Grain contracts
$
1.7
$
2.5
$
66.6
$
73.0
Livestock contracts
1.6
4.1
6.5
1.1
Foreign exchange contracts
—
0.2
0.8
0.1
Total
3.3
6.8
73.9
74.2
Derivatives using the "mark-to-market" method:
Grain contracts
5.2
6.2
6.9
13.7
Livestock contracts
8.8
12.4
1.1
0.7
Energy contracts
0.8
3.1
2.6
0.6
Foreign exchange contracts
0.1
0.6
0.7
0.3
Total
14.9
22.3
11.3
15.3
Total fair value of derivative instruments
$
18.2
$
29.1
$
85.2
$
89.5
Hedge Accounting Method
Cash Flow Hedges
We enter into derivative instruments, such as futures, swaps and options contracts, to manage our exposure to the variability in expected future cash flows attributable to commodity price risk associated with the forecasted sale of live hogs and fresh pork, and the forecasted purchase of corn and soybean meal. In addition, we enter into foreign exchange contracts to manage our exposure to the variability in expected future cash flows attributable to changes in foreign exchange rates associated with the forecasted purchase or sale of assets denominated in foreign currencies. As of July 28, 2013 , we had no cash flow hedges for forecasted transactions beyond April 2014 .
When cash flow hedge accounting is applied, derivative gains or losses are recognized as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings. Derivative gains and losses, when reclassified into earnings, are recorded in cost of sales for grain contracts, sales for lean hog contracts and selling, general and administrative expenses (SG&A) for foreign exchange contracts. Gains and losses on derivatives designed to hedge price risk associated with fresh pork sales are recorded in the Hog Production segment.
During the three months ended July 28, 2013 , the range of notional volumes associated with open derivative instruments designated in cash flow hedging relationships was as follows:
Minimum
Maximum
Metric
Commodities:
Corn
63,996,094
86,625,000
Bushels
Soybean meal
462,996
581,656
Tons
Lean hogs
248,600,000
453,480,000
Pounds
Foreign currency (1)
25,756,717
42,919,077
U.S. Dollars
——————————————
(1)
Amounts represent the U.S. dollar equivalent of various foreign currency contracts.
10
The following table presents the effects on our consolidated condensed financial statements of pre-tax gains and losses on derivative instruments designated in cash flow hedging relationships for the fiscal periods indicated:
Gains (Losses) Recognized in Other Comprehensive Income (Loss) on Derivative (Effective Portion)
Gains (Losses) Reclassified from Accumulated Other Comprehensive Loss into Earnings (Effective Portion)
Gains Recognized in Earnings on Derivative (Ineffective Portion)
Three Months Ended
Three Months Ended
Three Months Ended
July 28,
2013
July 29,
2012
July 28,
2013
July 29,
2012
July 28,
2013
July 29,
2012
(in millions)
(in millions)
(in millions)
Commodity contracts:
Grain contracts
$
(4.4
)
$
133.9
$
25.0
$
2.7
$
1.8
$
2.7
Lean hog contracts
(4.7
)
0.3
9.1
32.2
—
0.1
Foreign exchange contracts
(1.0
)
(1.8
)
(0.1
)
(0.2
)
—
—
Total
$
(10.1
)
$
132.4
$
34.0
$
34.7
$
1.8
$
2.8
For the fiscal periods presented, foreign exchange contracts were determined to be highly effective. We have excluded from the assessment of effectiveness differences between spot and forward rates, which we have determined to be immaterial.
As of July 28, 2013 , there were deferred net losses of $44.8 million , net of tax of $28.2 million , in accumulated other comprehensive loss. We expect to reclassify $2.2 million ( $1.3 million net of tax) of deferred net losses on closed commodity contracts into earnings within the next twelve months. We are unable to estimate the amount of unrealized gains or losses to be reclassified into earnings within the next twelve months related to open contracts as their values are subject to change.
Fair Value Hedges
We enter into derivative instruments (primarily futures contracts) that are designed to hedge changes in the fair value of live hog inventories and firm commitments to buy grains. When fair value hedge accounting is applied, derivative gains and losses are recognized in earnings currently along with the change in fair value of the hedged item attributable to the risk being hedged. The gains or losses on the derivative instruments and the offsetting losses or gains on the related hedged items are recorded in cost of sales for commodity contracts.
During the three months ended July 28, 2013 , the range of notional volumes associated with open derivative instruments designated in fair value hedging relationships was as follows:
Minimum
Maximum
Metric
Commodities:
Corn
335,000
4,130,000
Bushels
The following table presents the effects on our consolidated condensed statements of income of gains and losses on derivative instruments designated in fair value hedging relationships and the related hedged items for the fiscal periods indicated:
Gains (Losses) Recognized in Earnings on Derivative
Gains (Losses) Recognized in Earnings on Related Hedged Item
Three Months Ended
Three Months Ended
July 28,
2013
July 29,
2012
July 28,
2013
July 29,
2012
(in millions)
(in millions)
Commodity contracts
$
0.4
$
(26.4
)
$
(0.4
)
$
20.3
We recognized gains of $2.1 million and $3.4 million for the three months ended July 28, 2013 and July 29, 2012 , respectively, on closed commodity derivative contracts as the underlying cash transactions affected earnings.
For fair value hedges of inventory, we elect to exclude from the assessment of effectiveness differences between the spot and futures prices. These differences are recorded directly into earnings as they occur. These differences resulted in losses of $6.3 million for the three months ended July 29, 2012 . There were no fair value hedges of inventory in the first quarter of fiscal 2014, and therefore no differences between spot and futures prices were recognized for the three months ended July 28, 2013 .
11
Mark-to-Market Method
Derivative instruments that are not designated as a hedge, have been de-designated from a hedging relationship, or do not meet the criteria for hedge accounting are marked-to-market with the unrealized gains and losses together with actual realized gains and losses from closed contracts being recognized in current period earnings. Under the mark-to-market method, gains and losses are recorded in cost of sales for commodity contracts, and SG&A for foreign exchange contracts.
During the three months ended July 28, 2013 , the range of notional volumes associated with open derivative instruments using the “mark-to-market” method was as follows:
Minimum
Maximum
Metric
Commodities:
Lean hogs
15,160,000
82,400,000
Pounds
Corn
70,000
10,115,000
Bushels
Soybean meal
33,745
34,145
Tons
Soybeans
535,000
1,125,000
Bushels
Wheat
—
750,000
Bushels
Natural gas
8,470,000
9,520,000
Million BTU
Diesel
2,520,000
3,360,000
Gallons
Foreign currency (1)
26,926,504
57,108,648
U.S. Dollars
——————————————
(1)
Amounts represent the U.S. dollar equivalent of various foreign currency contracts.
The following table presents the amount of gains and losses recognized in the consolidated condensed statements of income on derivative instruments using the “mark-to-market” method by type of derivative contract for the fiscal periods indicated:
Three Months Ended
July 28,
2013
July 29,
2012
(in millions)
Commodity contracts
$
6.0
$
(8.2
)
Foreign exchange contracts
(0.3
)
4.6
Total
$
5.7
$
(3.6
)
The table above reflects gains and losses from both open and closed contracts including, among other things, gains and losses related to contracts designed to hedge price movements that occur entirely within a quarter. The table includes amounts for both realized and unrealized gains and losses. The table is not, therefore, a simple representation of unrealized gains and losses recognized in the income statement during any period presented.
12
NOTE 5 :
INVESTMENTS
Investments consist of the following:
Equity Investment
% Owned
July 28,
2013
April 28,
2013
(in millions)
Campofrío Food Group (CFG)
37%
$
384.3
$
376.2
Mexican joint ventures
50%
121.4
129.6
Other
Various
27.9
26.6
Total investments
$
533.6
$
532.4
We record our share of earnings and losses from our equity method investments in (income) loss from equity method investments. Some of these results are reported on a one-month lag which, in our opinion, does not materially impact our consolidated condensed financial statements.
Each quarter, we review the carrying value of our investments and consider whether indicators of impairment exist. Examples of impairment indicators include a history or expectation of future operating losses and declines in a quoted share price, among other factors. If an impairment indicator exists, we must evaluate the fair value of our investment to determine if a loss in value, which is other than temporary, has occurred. If we consider any such decline to be other than temporary (based on various factors, including historical financial results, product development activities and the overall health of the affiliate’s industry), then a write-down of the investment to its estimated fair value would be recorded. We have determined that no write-down was necessary for all periods presented.
As of July 28, 2013 , we held 37,811,302 shares of CFG common stock. Shares of CFG are publicly traded on the Bolsa de Madrid Exchange (Madrid Exchange). As the table below shows, the carrying value of our investment in CFG was above the quoted market price on the Madrid Exchange as of July 28, 2013 , indicating a possible impairment of our investment in CFG. However, we do not believe the quoted share price on the Madrid Exchange is, by itself, reflective of the fair value of our investment in CFG for the following reasons:
▪
The minority shares traded on the Madrid Exchange confer no special rights or privileges to buyers. In contrast, the shares comprising our 37% stake in CFG contractually entitle us to two seats on CFG's 9 -person board of directors, giving us the ability to exert significant influence over the strategic and operational decisions of our investee.
▪
The stock is very thinly traded. CFG is a closely held company, with the three largest shareholders owning approximately 74% of the outstanding shares. We are CFG's largest shareholder, with a 37% stake.
•
The average daily trading volume during last 27 months represents less than three hundredths of one percent of the total outstanding shares. The lack of an active market can cause significant fluctuations and volatility in the stock price that are not commensurate with fundamental changes in the underlying business and the fair value of our holding in CFG. Shares trading on the Madrid Exchange have ranged from a high of €9.28 ( $13.74 ) to a low of €4.12 ( $5.39 ) per share during the last 27 months, with upward and downward fluctuations in between.
The table below shows CFG's intra-day high share price and Smithfield's carrying value, expressed in euro per share, on various dates relevant to our disclosures.
Date
Share Price
Carrying Value
May 5, 2011
€
9.27
€
7.93
February 17, 2012
€
7.20
€
7.54
April 29, 2012 (1)
€
6.30
€
7.70
April 28, 2013 (1)
€
4.99
€
7.64
July 28, 2013 (1) (2)
€
5.22
€
7.65
——————————————
(1)
Share prices on quarter end date reflect the last trading day in the quarter.
(2)
During the first quarter of fiscal 2014, CFG's share price traded as high as €5.88 per share (May 30, 2013).
13
As noted above, we do not consider the share price on the Madrid Exchange, by itself, to be determinative of fair value. In assessing the fair value of our investment, we considered a variety of information, including an independent third party valuation report, which incorporates generally accepted valuation techniques, CFG's history of positive cash flows, expectations about the future cash flows of CFG, market multiples for comparable businesses, and an influence premium applied to the market price of CFG's shares on the Madrid Exchange to adjust for our contractual right to two board seats and our ability to exert significant influence over the operational and strategic decisions of the company.
Based on an evaluation of all these factors, we concluded the fair value of our investment in CFG as of July 28, 2013 , exceeded its carrying amount. However, our estimate of fair value has declined over the last 27 months, significantly eroding the gap between fair value and carrying value. The fair value decline is primarily attributable to persistent recessionary conditions in Western Europe, which have dampened CFG's current operating performance. In addition, CFG's share price on the Madrid Exchange has declined and, notwithstanding our reservations about the Madrid Exchange price, we nonetheless utilize it as a component of our valuation work and believe such declines must be considered as part of our fair value estimate. While we do not believe our investment is impaired as of July 28, 2013 , the confluence of these and other factors has decreased our estimate of CFG's fair value and increased the risk of impairment. If the trends contributing to our lower estimate of CFG's fair value continue, the investment would become impaired. Specifically, if the most sensitive factors affecting our fair value calculations (i.e., estimates of future cash flows, interest rates and share price) continue to deteriorate, it is reasonably possible that our estimate of fair value could fall below carrying value. If that occurs, and we determine that the decline is other than temporary, we would record a charge to income for the difference between the estimate of fair value and the carrying amount of our investment.
(Income) loss from equity method investments consists of the following:
Three Months Ended
Equity Investment
Segment
July 28,
2013
July 29,
2012
(in millions)
CFG (1)
International
$
(0.1
)
$
(0.1
)
Mexican joint ventures
International
3.0
0.4
All other equity method investments
Various
(1.2
)
(1.0
)
(Income) loss from equity method investments
$
1.7
$
(0.7
)
——————————————
(1)
CFG prepares its financial statements in accordance with International Financial Reporting Standards. Our share of CFG’s results reflects U.S. GAAP adjustments and thus, there may be differences between the amounts we report for CFG and the amounts reported by CFG.
14
NOTE 6 :
DEBT
Debt Retirement
In May 2013 (fiscal 2014), we repaid the remaining outstanding principal amount on our 7.75% senior unsecured notes totaling $55.0 million .
In July 2013 (fiscal 2014), we repaid the outstanding principal amount on our 4% senior unsecured convertible notes totaling $400.0 million (Convertible Notes). As part of the settlement of the Convertible Notes, we delivered 3,894,476 shares of our common stock to the holders of the notes. Simultaneously, we exercised our call option to acquire shares of our common stock, which we entered into in connection with the original issuance of the Convertible Notes, and received 3,894,510 shares from the counterparties. As a result, we retired 34 net shares of our common stock upon the settlement of the Convertible Notes.
Working Capital Facilities
As of July 28, 2013 , we had aggregate credit facilities and credit lines totaling $1.4 billion , including an inventory-based revolving credit facility totaling $1.025 billion (the Inventory Revolver), an accounts receivable securitization facility totaling $275.0 million (the Securitization Facility) and international credit facilities totaling $143.4 million . As of July 28, 2013 , our unused capacity under these credit facilities and credit lines was $823.2 million .
As part of the Securitization Facility agreement, all accounts receivable of our major Pork segment subsidiaries are sold to a wholly owned “bankruptcy remote” special purpose vehicle (SPV). The SPV pledges the receivables as security for loans and letters of credit. The SPV is included in our consolidated financial statements and therefore, the accounts receivable owned by it are included in our consolidated balance sheet. However, the accounts receivable owned by the SPV are separate and distinct from our other assets and are not available to our other creditors should we become insolvent. As of July 28, 2013 , the SPV held $500.5 million of accounts receivable and we had $170.0 million in outstanding borrowings on the Securitization Facility.
NOTE 7 :
GUARANTEES
As part of our business, we are a party to various financial guarantees and other commitments as described below. These arrangements involve elements of performance and credit risk that are not included in the consolidated condensed balance sheets. We could become liable in connection with these obligations depending on the performance of the guaranteed party or the occurrence of future events that we are unable to predict. If we consider it probable that we will become responsible for an obligation, we will record the liability on our consolidated balance sheet.
As of July 28, 2013 , we continued to guarantee $9.9 million of leases that were transferred to JBS S.A. in connection with the sale of Smithfield Beef, Inc. This guaranty may remain in place until the leases expire through February 2022.
NOTE 8 :
PENSION PLANS
The components of net periodic pension cost consist of:
Three Months Ended
July 28,
2013
July 29,
2012
(in millions)
Service cost
$
13.6
$
11.8
Interest cost
19.8
18.7
Expected return on plan assets
(21.3
)
(19.7
)
Net amortization
14.9
13.2
Net periodic pension cost
$
27.0
$
24.0
15
NOTE 9 :
SHAREHOLDERS’ EQUITY
Stock Options and Performance Share Units
During the three months ended July 28, 2013 , we issued 83,503 shares of common stock upon the exercise of stock options and 187,398 shares of common stock for vested performance share units. In fiscal 2013 , we issued 253,018 shares of common stock upon exercise of stock options and 325,975 shares of common stock for vested performance share units.
Other Comprehensive Income (Loss)
The following table presents changes in the accumulated balances for each component of other comprehensive income (loss) and the related effects on net income of amounts reclassified out of other comprehensive income (loss).
Three Months Ended
July 28, 2013
July 29, 2012
Before Tax
Tax
After Tax
Before Tax
Tax
After Tax
(in millions)
Foreign currency translation:
Translation adjustment arising during the period
$
7.1
$
(2.8
)
$
4.3
$
(90.3
)
$
6.2
$
(84.1
)
Pension accounting:
Amortization of actuarial losses and prior service credits reclassified to cost of sales
4.3
(1.7
)
2.6
9.3
(3.6
)
5.7
Amortization of actuarial losses and prior service credits reclassified to SG&A
10.6
(4.1
)
6.5
4.0
(1.5
)
2.5
Hedge accounting:
Gains (losses) arising during the period
(10.1
)
3.8
(6.3
)
132.4
(51.9
)
80.5
Gains reclassified to sales
(9.1
)
3.6
(5.5
)
(32.2
)
12.5
(19.7
)
Gains reclassified to cost of sales
(25.0
)
9.7
(15.3
)
(2.7
)
1.0
(1.7
)
Losses reclassified to SG&A
0.1
—
0.1
0.2
(0.1
)
0.1
Total other comprehensive income (loss)
$
(22.1
)
$
8.5
$
(13.6
)
$
20.7
$
(37.4
)
$
(16.7
)
NOTE 10 :
FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We are required to consider and reflect the assumptions of market participants in fair value calculations. These factors include nonperformance risk (the risk that an obligation will not be fulfilled) and credit risk, both of the reporting entity (for liabilities) and of the counterparty (for assets).
We use, as appropriate, a market approach (generally, data from market transactions), an income approach (generally, present value techniques), and/or a cost approach (generally, replacement cost) to measure the fair value of an asset or liability. These valuation approaches incorporate inputs, such as observable, independent market data, that management believes are predicated on the assumptions market participants would use to price an asset or liability. These inputs may incorporate, as applicable, certain risks such as nonperformance risk and credit risk.
16
The FASB has established a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The fair value hierarchy gives the highest priority to quoted market prices (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of inputs used to measure fair value are as follows:
▪
Level 1—quoted prices in active markets for identical assets or liabilities accessible by the reporting entity.
▪
Level 2—observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
▪
Level 3—unobservable for an asset or liability. Unobservable inputs should only be used to the extent observable inputs are not available.
We have classified assets and liabilities measured at fair value based on the lowest level of input that is significant to the fair value measurement. For the periods presented, we had no transfers of assets or liabilities between levels within the fair value hierarchy. The timing of any such transfers would be determined at the end of each reporting period.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables set forth, by level within the fair value hierarchy, our non-pension financial assets and liabilities that were measured at fair value on a recurring basis as of July 28, 2013 and April 28, 2013 :
July 28, 2013
April 28, 2013
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
Total
(in millions)
(in millions)
Assets
Derivatives:
Commodity contracts
$
—
$
—
$
—
$
—
$
6.8
$
—
$
—
$
6.8
Foreign exchange contracts
—
0.1
—
0.1
—
0.8
—
0.8
Open-ended mutual funds
5.8
—
—
5.8
6.4
—
—
6.4
Insurance contracts
—
61.5
—
61.5
—
60.0
—
60.0
Total
$
5.8
$
61.6
$
—
$
67.4
$
13.2
$
60.8
$
—
$
74.0
Liabilities
Derivatives:
Commodity contracts
$
29.5
$
36.1
$
—
$
65.6
$
30.5
$
37.1
$
—
$
67.6
Foreign exchange contracts
—
1.5
—
1.5
—
0.4
—
0.4
Total
$
29.5
$
37.6
$
—
$
67.1
$
30.5
$
37.5
$
—
$
68.0
The following are descriptions of the valuation methodologies and key inputs used to measure financial assets and liabilities recorded at fair value on a recurring basis:
▪
Derivatives— Derivatives classified within Level 1 are valued using quoted market prices. In some cases where quoted market prices are not available, we value the derivatives using pricing models based on the net present value of estimated future cash flows to calculate fair value, in which case the measurements are classified within Level 2. These valuation models make use of market-based observable inputs, including exchange prices and rates, yield curves, credit curves, and measures of volatility.
▪
Open-ended mutual funds —Open-ended mutual funds are valued at their net asset value (NAV), which approximates fair value, and classified as Level 1.
▪
Insurance contracts— Insurance contracts are valued at their cash surrender value using the daily asset unit value (AUV) which is based on the quoted market price of the underlying securities and classified within Level 2.
17
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition; that is, the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances, for example, when there is evidence of impairment. During the three months ended July 28, 2013 , we had no significant assets or liabilities that were measured and recorded at fair value on a nonrecurring basis.
Other Financial Instruments
We determine the fair value of public debt using Level 2 inputs based on quoted market prices. The carrying amount of all other debt approximates fair value as those instruments are based on variable interest rates. The following table presents the fair value and carrying value of long-term debt, including the current portion of long-term debt as of July 28, 2013 and April 28, 2013 .
July 28, 2013
April 28, 2013
Fair
Value
Carrying Value
Fair
Value
Carrying Value
(in millions)
Long-term debt, including current portion
$
2,611.4
$
2,475.5
$
2,732.9
$
2,479.1
The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate their fair values because of the relatively short-term maturity of these instruments.
NOTE 11 :
CONTINGENCIES
Like other participants in the industry, we are subject to various laws and regulations administered by federal, state and other government entities, including the United States Environmental Protection Agency (EPA) and corresponding state agencies, as well as the United States Department of Agriculture, the Grain Inspection, Packers and Stockyard Administration, the United States Food and Drug Administration, the United States Occupational Safety and Health Administration, the Commodities and Futures Trading Commission and similar agencies in foreign countries.
We from time to time receive notices and inquiries from regulatory authorities and others asserting that we are not in compliance with such laws and regulations. In some instances, litigation ensues. In addition, individuals may initiate litigation against us.
North Carolina Nuisance Litigation
On July 30, 2013, five complaints were filed in the Superior Court of Wake County, North Carolina by 135 individual plaintiffs against Smithfield, our wholly owned subsidiary, Murphy-Brown, and various individuals and entities who are alleged to own or operate farms under contract with Murphy-Brown. Alderman, et al. v. Smithfield Foods, Inc., et al. , involves allegations brought by 20 plaintiffs alleged to reside in Duplin County, North Carolina against Smithfield, Murphy-Brown, and two additional defendants representing two independent growers and their farms. Aultman, et al. v. Smithfield Foods, Inc., et al. , involves allegations brought by 23 plaintiffs alleged to reside in Duplin County, North Carolina against Smithfield, Murphy-Brown, and five additional defendants representing four independent growers and their farms and one Company-owned farm. Best, et al. v. Smithfield Foods, Inc., et al. , involves allegations brought by 25 plaintiffs alleged to reside in Wilson County, North Carolina against Smithfield, Murphy-Brown, and one additional defendant representing one independent grower and its farm. Blanks, et al. v. Smithfield Foods, Inc., et al. , involves allegations brought by 26 plaintiffs alleged to reside in Bladen County, North Carolina against Smithfield, Murphy-Brown, and three additional defendants representing two independent growers and their farms and one Company-owned farm. Bordeaux, et al. v. Smithfield Foods, Inc., et al. , involves allegations brought by 41 plaintiffs alleged to reside in Duplin County, North Carolina against Smithfield, Murphy-Brown, and four additional defendants representing two independent growers and their farms.
On August 27, 2013, a sixth complaint, titled Cromartie, et al. v. Smithfield Foods, Inc., et al. , was transmitted to the Superior Court of Wake County, North Carolina for filing by 32 plaintiffs alleged to reside in Bladen County, North Carolina against Smithfield, Murphy-Brown, and five additional defendants representing two independent growers and their farms and two Company-owned farms. On August 28, 2013, a seventh complaint, titled Bannerman, et al. v. Smithfield Foods, Inc., et al . , was transmitted to the Superior Court of Wake County, North Carolina for filing by 14 plaintiffs alleged to reside in Duplin County, North Carolina against Smithfield, Murphy-Brown, and ten additional defendants representing six independent growers and their farms and three Company-owned farms. All seven complaints include causes of action for temporary nuisance,
18
negligence, and negligent entrustment and seek recovery of an unspecified amount of compensatory and punitive damages, attorneys' fees, costs and pre- and post-judgment interest. Defendants are in the process of preparing responsive pleadings in all seven cases.
All seven complaints stemmed from requests for pre-litigation mediation of farm nuisance disputes filed in early July 2013 in Wake County, North Carolina. Plaintiffs' counsel have filed pre-litigation mediation notices on behalf of approximately 500 additional claimants who have not filed complaints. Approximately 300 additional potential claimants have threatened to bring claims but not initiated any formal legal process. The Company believes that the allegations are unfounded and intends to defend the suits vigorously.
Our policy for establishing accruals and disclosures for contingent liabilities is contained in Note 1-Summary of Significant Accounting Policies in our Annual Report on Form 10-K for the fiscal year ended April 28, 2013. We have not made an accrual on these loss contingencies. Given that this matter is in its very preliminary stages and given the inherent uncertainty of the outcome for these and similar potential claims, we cannot estimate the reasonably possible loss or range of loss for these loss contingencies. We will continue to review whether an accrual is necessary and whether we have the ability to estimate the reasonably possible loss or range of loss for these matters.
NOTE 12 :
REPORTABLE SEGMENTS
Our operating segments are determined on the basis of how we internally report and evaluate financial information used to
make operating decisions and assess performance. For external reporting purposes, we aggregate operating segments which
have similar economic characteristics, products, production processes, types or classes of customers and distribution methods
into reportable segments based on a combination of factors, including products produced and geographic areas of operations.
Our reportable segments are: Pork, Hog Production, International, Other and Corporate, each of which is comprised of a
number of subsidiaries, joint ventures and other investments. The Pork segment consists mainly of our three wholly owned U.S. fresh pork and packaged meats subsidiaries : The Smithfield Packing Company, Inc., Farmland Foods, Inc. and John Morrell Food Group. The Hog Production segment consists of our hog production operations located in the U.S. The International segment is comprised mainly of our meat processing and distribution operations in Poland, Romania and the United Kingdom, our interests in meat processing operations, mainly in Western Europe and Mexico, our hog production operations located in Poland and Romania and our interests in hog production operations in Mexico. The Corporate segment provides management and administrative services to support our other segments.
19
The following table presents sales and operating profit (loss) by segment for the fiscal periods indicated:
Three Months Ended
July 28,
2013
July 29,
2012
(in millions)
Sales:
Segment sales—
Pork
$
2,850.4
$
2,599.6
Hog Production
872.4
728.8
International
376.0
346.8
Total segment sales
4,098.8
3,675.2
Intersegment sales—
Pork
(11.5
)
(8.4
)
Hog Production
(684.6
)
(567.3
)
International
(9.4
)
(8.2
)
Total intersegment sales
(705.5
)
(583.9
)
Consolidated sales
$
3,393.3
$
3,091.3
Operating profit:
Pork
$
61.4
$
118.6
Hog Production
66.5
23.1
International
1.9
15.8
Corporate
(32.5
)
(25.7
)
Consolidated operating profit
$
97.3
$
131.8
NOTE 13 :
SUBSEQUENT EVENTS
Sun Merger Sub, Inc. Debt Offering
In May 2013 (fiscal 2014), we announced that we had entered into an Agreement and Plan of Merger with Shuanghui International Holdings Limited, a corporation formed under the laws of the Cayman Islands (Shuanghui) and Sun Merger Sub, Inc., a Virginia corporation and wholly owned subsidiary of Shuanghui (Merger Sub), pursuant to which Merger Sub will merge with and into the Company (the Merger), with the Company surviving the Merger as a wholly owned subsidiary of Shuanghui.
On July 31, 2013, Merger Sub issued $500.0 million aggregate principal amount of 5.25% senior notes due August 1, 2018 and $400.0 million aggregate principal amount of 5.875% senior notes due August 1, 2021 (together, the Merger Sub Notes) as part of the financing for the Merger. Upon the consummation of the Merger and release of the proceeds from escrow, the Merger Sub Notes will become unsecured obligations of the Company ranking equally in right of payment with all of our existing and future senior unsecured indebtedness.
20
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.